Comparing Dairy Proposals in the 2012 Farm Bill: Supply Management &

Other Initiatives

Mark StephensonUniversity of Wisconsin

Chuck NicholsonCal Poly San Luis Obispo

Outline

• Focus on price volatility and policy options

• What causes price variation?

• Analysis of programs to reduce variation– FFTF (DMSP and DPIPP)– Margin insurance (only)– Farm Savings Accounts

All-Milk Price 1990-2011

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Class III and IV Prices 1990-2011

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Why this Volatility?

Three main reasons proposed:

• Random shocks

• Government policy

• Price cycles due to supply chain behaviors

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Feed Costs: A Supply Shock

Exports: A Demand Shock

Index of Feed, Exports All-milk

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Shocks matter more here

Shocks less important here

Shocks

• Contribute to volatility but don’t appear to be the only cause

• Clearly in 2007-2010, but not as clearly before

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Government Policy

• Federal (or State) Milk Marketing Orders cause volatility– Milk doesn’t move to “highest and best use”– Delays in reporting and price formulas

• May contribute some, but evidence is limited– Doesn’t seem to explain longer-term cycles in

prices and profitability– Many commodities have volatility without MOs

or other price regulation10

Supply Chain Behaviors

• Many commodities have price and production cycles– Milk– Cattle– Aircraft– Electricity Generation

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Why Price Cycles?

• One reason: more farms expand when times are good– This is logical for the individual farm if a good

long-term investment…

• But this often leads to times that are not so good

• The issue is that the supply decisions are not coordinated– So the market “overshoots” and “corrects”

• This is very common in supply chains12

Dairy Price Cycles

• In previous work, we identified a number of price cycles:

• Seasonal (still with us)

• 9-month

• 26-month

• 36-month (largest cycle)

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All-Milk Price Cycles

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Main Approaches to Reduce Volatility…

• Probably need to do two things:

• Make the dairy supply chain better able to handle shocks– Hold more inventories of product (although

costly)

• Change the fundamental behaviors that lead to price cycles– Reduce incentives for response to large price

swings (which appear to create price swings)15

Many Programs Proposed

• Refundable Assessments (Milk Producers’ Council, 2007)

• Mandatory CWT (Dairy Farmers Working Together, 2007)

• Growth Management Plan (Milk Producer’s Council, 2009)

• Dairy Growth Management Initiative (DFA, 2009)

• Marginal Milk Pricing (AgriMark, 2010)

• Dairy Market Stabilization Program (NMPF, 2010)

• Farm Savings Accounts (discussed by DIAC, 2010)

• Margin Insurance Programs (NMPF’s DPMPP and discussed by DIAC, 2010-11)

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Foundation for the Future

• New Safety Net– Get rid of Milk Income Loss Contracts– Get rid of Dairy Product Price Support Program– Replace with Margin Protection Program

• Federal Milk Marketing Order Reform• Dairy Market Stabilization Program

– Rolling 3-month base or year earlier month– Use Margin triggers– No payment for a portion over base– Money from penalty milk used on demand programs

Dairy Market Stabilization Program

• The DMSP is a temporary, stand-by program that activates if the “margin” falls below the trigger margin for 2 consecutive months

• Once the DMSP is triggered, a temporary “base” is established for each dairy facility. That “base is either:– A rolling 3-month average of the most recent milk

marketing immediately prior to DMSP implementation

OR– The same month in the previous year

The DMSP “Triggers”

• <$6 for 2 consecutive months– Producers paid for 98% of their base milk– Maximum reduction is 6% of current milk

• <$5 for 2 consecutive months– Producers paid for 97% of their base milk– Maximum reduction is 7% of current milk

• <$4 for 1 month– Producers paid for 96% of their base milk– Maximum reduction is 8% of current milk

The DMSP “Triggers”

• The DMSP is in effect until the margins are above $6.00 per cwt for two consecutive months. Then the program ends and the “base” is extinguished.

• Monies paid by handlers for milk produced in excess of these levels will go into a fund, to be managed by a producer board and used to “stimulate the consumption of dairy products.”

Dairy Producer Margin Protection Program

• The DPPMP utilizes the same margin calculation as the DMSP: National all milk price minus national average feed cost.

• All producers have the option of signing up for either the base coverage or the base + supplemental coverage.

• The base coverage is free for the producer; the supplemental coverage has an annual premium.

Dairy Producer Margin Protection Program

• Each dairy’s coverage is based on that dairy’s production history.– A dairy can get coverage for up to 90% of

their highest annual production in the three years prior to this program’s implementation.

– That volume is locked in for the next five years. The dairy cannot get coverage under the DPMPP for production above that level during the five-year life of the program.

Dairy Producer Margin Protection Program

• $4 base margin coverage is free

• Partially subsidized premiums for supplemental coverage.

FFTF Margin

Analysis of the Programs

• Dairy industry consortium requested study of various options– FFTF (without Federal Order reform)– Marginal Milk Pricing– Growth Management Program– Completed in September 2010

• DIAC requested analysis of margin plans and farm savings accounts– Completed by February 2010

Volatility is Focus…

• Would the 3 programs reduce the variability the U.S. average All-Milk price?– Compared to a situation with only current

dairy programs– Note: NOT enhance milk prices or incomes

• Can we reduce volatility without supply management?– What would it cost to do this?

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…but other impacts matter

• What would some other key impacts be of the 2 programs?– Average All-Milk price– Class III prices– Cheese net export sales– Government costs

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Our Analysis

• Used a dynamic systems simulation model– Monthly values from 2010 to 2019

• Developed “Baseline” outcomes– What would happen if there are no new

programs

• Compared outcomes with each program to the Baseline– What changes between the two tells us the

impact of the program

• Did this without and with shocks– Feed costs and export demand

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How Helpful are Models?

• We can’t avoid the use of models to analyze these options

• We do have two basic choices, though

• MATHEMATICAL models– Like the one just described

• MENTAL models– Individuals’ view of how things work

• These complement one another– There are limits to both

Aside #1

Examine Three Options

• FFTF– Dairy Market Stabilization Plan – Dairy Producer Margin Protection Plan

• Margin Insurance Program– No supply management, No DPPSP or MILC

• Farm Savings Accounts– No supply management, No DPPSP or MILC

• These illustrate but don’t cover all possible

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FFTF Analysis

• DMSP and DPIPP Elements– Not order reform– Preliminary version, not exactly the same as

program announced

• $6/cwt margin trigger for DMSP• Margin insurance for DPIPP

– $4/cwt base margin protection– $6/cwt supplemental protection– $0.14/cwt premium for supplemental

Margin Insurance Analysis

• Base plan at no cost to producers– Protects $4 margin of milk less feed cost– Up to a cap of 2.4 million lbs

• Supplemental plan with 2 tiers– Tier 1 protects $6 margin, $0.30/cwt premium

for covered milk– Tier 2 protects $8 margin, $1.62/cwt premium

for covered milk

• Elimination of DPPSP and MILC32

Farm Savings Account Analysis

• Producer contributions– Based on difference between current year and

average year income– Assumed a % of this contributed

• Government matching– 1 to 1 up to $10,000 match– 4 to 1 up to $40,000 total match– Under $750,000 NFOI for eligibility

• Elimination of DPPSP and MILC

What We Found

• Both programs could reduce variability in the All-Milk price

• Programs have different impacts on the average All-Milk price

• Programs have different impacts on Class III prices

• Programs have different impacts on cheese net exports

• Programs have different impacts on government expenditures (taxpayer $)

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Variability of the All-Milk Price(No Shocks)

35Note the “path dependency.” Program changes pattern of prices.

Using Past Data?

• “Path dependency” means program changes future outcomes– In this case, the pattern of prices

• Implication: don’t past price series to examine the potential impacts of a proposed program– If the program is likely to change the pattern

• Example: comparing MILC to DPIPP– Using data for 2002 to 2010

Aside #2

Variability of the All-Milk Price(No Shocks)

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Variation in All-Milk Price

Variable Baseline FFTFMargin

Insurance Only

Farm Savings

Accounts

Change from Baseline

All-Milk price, average 2013-2019, $/cwt

15.32 +0.17 -0.21 +0.06

Variation of All-Milk Price, 2013-2019, $/cwt

0.83 -0.48 -0.41 -0.18

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Variation in All-Milk price is reduced by programs

Variation in All-Milk Price

Variable Baseline FFTFMargin

Insurance Only

Farm Savings

Accounts

Change from Baseline

All-Milk price, average 2013-2019, $/cwt

15.32 +0.17 -0.21 +0.06

Variation of All-Milk Price, 2013-2019, $/cwt

0.83 -0.48 -0.41 -0.18

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All-Milk price impact varies

Do Programs Help with a Meltdown?

• Do they prevent a prolonged period of low prices?– In response to major shocks

• Do they make the recovery faster?

• We examined shocks to feed costs and exports similar to what occurred in 2007-2009– 20% increase in feed costs

– Large increase in US exports for one year

– Decrease in US exports for the following year

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All-Milk Price With Shocks

41Range of values reduced

Shocks assumed to begin in 2015

Programs With Shocks

• Less effective than in absence of shocks– To be expected

• But still mitigate price variability

• Reduce length of time that prices are low after large shock

Class III Price

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(No Shocks)

Average Class III Price

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Variable Baseline FFTFMargin

Insurance Only

Farm Savings

Accounts

Change from Baseline

All-Milk price, average 2013-2019, $/cwt

15.32 +0.17 -0.21 +0.06

Variation of All-Milk Price, 2013-2019, $/cwt

0.83 -0.48 -0.41 -0.18

Average Class III Price, 2013-2019, $/cwt

13.43 +0.71 -0.23 +0.13

Net Farm Operating Income

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(No Shocks)

For our “Small” farm size < 250 cows

Cheese Net Exports

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(No Shocks)

Cumulative Gov’t Expenditures

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(No Shocks)

Summary of Effects

• Programs analyzed would reduce volatility

• Programs could reduce the negative effects of major shocks

• Have differing effects on All-milk price, Class III price, cheese net exports and government expenditures

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Not A Simple Story

• Tendency to pick and choose effects that either like or don’t like

• Encourage a broad perspective of the different impacts

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